Commercial Bank Financing


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Commercial Bank Financing

  1. 1. Financing Retail Installment Transactions The larger, more expensive the item, the less likely the consumer is to use a credit card for the purchase. The item is often purchased using an installment credit plan with regular, fixed monthly payments over several months or years. The retailer can make the loan to the consumer directly – “carry the paper in-house.” More likely the retailer will seek indirect financing of the purchase, selling the installment paper to a commercial bank or finance company after the sale or having the consumer deal with the bank or finance company before the sale is completed. Carrying the installment paper themselves means retailers have to raise more funds to finance the accounts receivable. Commercial Bank Financing Direct Approach Banks can simply make loan commitments directly with consumers. The bank has much greater control over the credit process, gets to know the customer well before extending credit, and can broaden and control the type and volume of installment business in its trading area. But loan business generated this way is much less important than the indirect method, walk-in business is usually low, and repossession is usually more difficult than when a dealer is involved.
  2. 2. -2- Indirect Approach Also called the dealer method. This method is much more prevalent than the direct method. A dealer takes the credit application in association with the sale of some item. The bank approves (or disapproves) the application and gives the money to the dealer. The customer than pays the bank the monthly payments. Possible problems: • Bank has no chance to get to know the customer personally. • Indirect borrowers are often less conscientious toward payments on the loans than are direct borrowers. • Fraud and misrepresentation are easier for the borrower if the bank doesn’t see the borrower personally. • The dealers can be far less interested in the creditworthiness of customers than the bank will be. Banks like indirect installment credit despite the possible problems because a high volume of loans can be generated easily. Banks consider the dealers’ financial and business history as well as their reputation and character. The most profitable relationship for the bank will be one with a dealer who is also trustworthy and makes credit sales to creditworthy customers. Banks consider the following when looking at dealers: • Current and past financial statements • Deposit relations with the bank • Trade references
  3. 3. -3- • Distributor or manufacturer relations • Credit reports from credit reporting agencies • Experience of other financial institutions with dealers • Reputation at Better Business Bureau Bank polices in relationship with dealers: • Bank must be able to make quick decisions on loans dealers originate with customers • Bank personnel must thoroughly understand dealers’ selling and credit problems • Bank must have effective collection policy • Bank must adopt competitive loan terms • Bank may provide inventory financing to dealers • Bank must have effective account monitoring procedures • Bank should extend other banking services to dealers Financing Plans Available to Dealers Full Recourse. Dealer guarantees the loan. If the borrower defaults, the dealer must come up with the balance due. Dealer has responsibility for handling any collateral. But dealer gets a lower discount rate. (Dealers don’t get the full amount of the loan when the bank finances the sale.) Nonrecourse. The bank assumes the risk of default and handling any repossession. Repurchase. Dealer has to buy back the product for the unpaid balance. Bank has to do the repossessing first.
  4. 4. -4- Dealer Reserve A dealer reserve is an account at a bank maintained as an agreement between the bank and the dealer to help protect the bank and dealer against the dealer’s contingent liability (assuming the dealer still has some responsibility for the paper bought by the bank). The bank charges customers a higher rate than it would charge the dealer. The difference can be put into the dealer reserve account in case of borrower’s default and dealer’s liability being activated. The dealer reserve can be used by the dealer to help satisfy some of the new liability. Inventory Financing Commercial banks finance inventory of retail dealers. Also known as flooring, floor planning or wholesale floor plan. It is common in auto dealerships. Bank loans money to dealers so they can buy cars and the loan is paid off as the cars are sold. The bank also probably finances the car purchase by the customer. Sales Finance Companies Sales finance companies perform the same services for dealers that commercial banks do but the sales finance company specializes in just sales finance. They do not loan directly to consumers. Sales finance companies may be subsidiaries of other companies: GMAC. Sales finance companies are common in auto loans but also deal in boats, aircraft, manufactured homes, farm machinery, etc.
  5. 5. -5- In General Dealers and banks often create long-term relationships with each other. Competition between financial institutions for installment contracts is intense. Approval of loans to customers by banks and sales finance companies can be very rapid. Competition keeps the financial institutions continually improving their services. Computers can make approvals almost instantly with links to appropriate credit rating services. A rejected application can be looked at by a human for a second chance.